39. The next auction of spectrum for mobile use
is due to take place in the last quarter of 2012. Although it
was originally scheduled for early 2012, Ofcom delayed the auction
date in order to hold an extra round of consultation.[38]
The auction will allocate spectrum in the 800 MHz and 2.6 GHz
bands. This will be the largest ever single award in the UK of
internationally harmonised mobile spectrum in the "sweet-spot".[39]
Internationally harmonised spectrum is crucial for mobile operators
as it allows users to cross international borders and maintain
mobile coverage. The combined auction of the 800 MHz and 2.6 GHz
spectrum will deliver an additional 250 MHz of spectrum. The spectrum
being auctioned in the 800 MHz band has been freed up as a result
of the UK digital switchover of television broadcasting, and is
suitable for delivering 4G mobile broadband services.

40. The 800 MHz spectrum being auctioned has
characteristics that are particularly suitable for allowing 3G
coverage over wide areas, and therefore could result in improved
coverage in rural areas, a topic that is discussed in greater
detail later in this Report. The 2.6 GHz spectrum being auctioned
is particularly suitable for carrying high capacity and coping
with demand in urban areas.

Ofcom's auction proposals

41. On 22 March 2011, Ofcom published its Consultation
on assessment of future mobile competition and proposals for the
award of 800 MHz and 2.6 GHz spectrum and related issues, which
contained a number of proposals about the rules under which the
auction should be conducted.

42. Ofcom's consultation proposes that the next
spectrum auction should be conducted using the "combinatorial
clock" method which has been used for previous spectrum auctions.
Ofcom will set prices for the lots of spectrum to be sold and
bidders will have to indicate if they are willing to accept the
prices. Ofcom will then increase the prices in stages until only
one bidder remains.

43. Ofcom has proposed mechanisms designed to
create an outcome whereby four viable MNOs emerge from the auction,
all able to compete effectively in future mobile markets. To achieve
this, Ofcom has also proposed having caps and floors on the amount
of spectrum each MNO can hold, as well as imposing a coverage
obligation on one of the 800 MHz licences to provide services
to 95% of the UK population.

THE NUMBER OF MOBILE NETWORK OPERATORS

44. Ofcom's proposal that there should be at
least four mobile operators after the auction is a measure designed
to maintain competitive tension in the market, which benefits
consumers. Ed Richards said in Ofcom's annual evidence session
with us on 3 May 2011 that if there were not an MNO quota set
for after the auction "you might as well just have a spectrum
free-for-all" and that "both ordinary individuals and
businesses would pay for that in the long term".[40]

45. Arqiva, the media technology company that
provides much of the infrastructure behind television, radio and
mobile communications, said in its written submission that, while
it agrees with Ofcom's proposals to maintain four mobile operators,
the whole premise of spectrum auctions may be becoming outdated
because "competition is increasingly focussed at the service
layer".[41] Julian
McGougan, Head of Public Policy and Regulatory Affairs at Arqiva,
said that the fact that MNOs shared infrastructure, and might
share spectrum in the future, meant that "the likelihood
is that, if Ofcom secures the outcome it is aiming for, it will
have to come back and review that afterwards".[42]

46. The spectrum market already allows for consolidation
and network sharing, subject to competition regulations, as the
merger between Orange and T-Mobile demonstrates. The Minister
for Culture, Communications and Creative Industries, Ed Vaizey,
said that he could "have a philosophical view that four mobile
operators is a good thing, but that does not mean that there will
not be consolidation in the industry".[43]

47. From the evidence we have
heard, we believe that Ofcom's proposal to secure at least four
mobile network operators after the next spectrum auction is an
adequate measure to safeguard plurality of mobile network operation.
We are reassured that four is a minimum rather than a limit, as
imposing such an artificial constraint on the number of operators
in the market would inhibit competition.

SPECTRUM CAPS AND FLOORS

Floors

48. In its consultation Ofcom proposes that,
after the auction, there should be at least four holders of a
minimum spectrum portfolio that are "credibly capable of
offering high quality data services in the future".[44]
It proposes:

to implement this through use of spectrum 'floors'
in the auction. This involves disregarding any potential auction
outcome in which a minimum number of licensees (currently proposed
to be four) do not win at least the minimum amount of spectrum.
We expect competition in the auction to determine how much spectrum
each bidder in fact wins and anticipate that this may well exceed
the minimum that we propose to set, but we nevertheless consider
it important for competition that we put in place this back-stop
provision.[45]

49. Both O2 and Vodafone told us that they objected
to the proposal for spectrum floors. They argue that, because
O2 and Vodafone already have 4G capable sub-1 GHz spectrum (the
liberalised 900 MHz licences), in order for Ofcom to achieve its
proposed outcome of four MNOs that can provide 4G services, Everything
Everywhere and Three will have an advantage bidding for the 800
MHz spectrum at the auction. O2's submission states that "the
spectrum floors are specifically designed to ensure that [O2]
and Vodafone are not guaranteed to win any 4G spectrum on the
erroneous presumption that their existing spectrum holdings will
suffice".[46] Ronan
Dunne, Chief Executive of O2, told us that he thought spectrum
floors could inhibit competition because "the floors mean
that certain existing operators are essentially guaranteed an
allocation of spectrum" because they do not already have
sub-1 GHz spectrum.[47]

Caps

50. Ofcom has stated that there is a possibility
that "one or more players might seek to corner the market
in this additional mobile spectrum in order to restrict competition".[48]
To counteract this it proposes to "impose spectrum caps in
the auction so that no one player can acquire so much spectrum
through the auction, relative to others, that competition might
be distorted in future".[49]

51. The alternative to caps considered by Ofcom
was to require O2 and Vodafone to give up some of their liberalised
900 MHz spectrum holdings before the auction. It decided instead
to propose the imposition of a spectrum cap, which would "have
the effect of limiting the amount of 800 MHz spectrum that Vodafone
and O2 could acquire in the auction".[50]

52. Unsurprisingly, Vodafone and O2 protest that
caps will "distort competition",[51]
and Everything Everywhere and Three suggest that they do not go
far enough.[52] Vodafone
states that the caps would allow "Everything Everywhere to
buy 2 x 25 MHz or over 80% of the sub-1 GHz spectrum for sale
in the auction. This could have potentially serious consequences
for competition in the future by creating a two-tier market".[53]
Taking the opposite view, Three thinks Ofcom's proposals for spectrum
caps do not go far enough. In its written submission it proposed
that "Ofcom should revise its proposed overall spectrum cap
to 2 x 95 MHz at most rather than 2 x 105 MHz. This would limit
the largest possible spectrum holding to 33% of total available
spectrum".[54]

53. Ofcom is faced with the difficult task of
finding a compromise between the two opposing views held by the
MNOs. Its proposal to introduce floors and caps is supported by
DCMS. Ed Vaizey told us that he was "very much a floor and
ceiling man".[55]

54. Those mobile network operators
with sub-1 GHz spectrum play down any advantage it may offer,
stating that they are not immediately able to use it for 3G because
the spectrum is already in use by 2G customers, who cannot simply
be cut off. Those operators without sub-1 GHz spectrum claim to
be frozen out of the market. These irreconcilable claims highlight
the difficulties faced by Ofcom in overseeing competition in the
spectrum market place. Ofcom's approach has been to liberalise
spectrum allocation but there still remain some vestiges of a
historical "command and control" approach to market
regulation, which Ofcom itself has criticised. Not all operators
start out on an equal footing, but by over-compensating for differences
in their positions, Ofcom would risk reversion to the command
and control principles from which it has been distancing itself
since its inception in 2003.

55. We believe that the spectrum
floors and caps proposed for the next auction are the best viable
compromise to ensure a competitive tension in the market place
in the context of the liberalised 900 MHz licences.